Keeping the balance
VBL has been one of the quiet pensions giants in Germany, leading a sheltered life in Karlsruhe for decades. But not any longer. “We are one of the biggest pension institutions in Germany and the biggest for the public sector employees, both at federal and at Länder level,” explains managing director Richard Peters. He is a strong champion of its cause.
The history of the Versorgung-sanstalt des Bundes und der Länder(VBL) goes back to 1929, when it was established in Berlin. It now covers some two million active members and one million pensioners and has assets of around E8bn, ranking it 36th in IPE’s Top 750 continental European pension bodies.
Since inception, its purpose always has been to address the imbalance in the pensions treatment to employees in the public sector who did not have the permanent civil service status, both at federal and state (Länder) level. “Civil servants doing the same work received a much higher retirement pension than ordinary employees,” he says. The original aim was to use the top-up principle to provide the same generous level of pension that civil servants obtained. “An individual top-up pension was calculated on the basis of the pension legislation for civil servants.”
Initially, it was on a fully funded basis. But the approach adopted by VBL has been reconstituted several times in its history, usually due to financial pressures faced by the public sector employers, who until recently were the main contributors to the arrangement.
In the 1950s, VBL moved to Karlsruhe when its approach was changed. Instead of paying top-up pensions as supplementary benefit, the amount paid was calculated as a percentage of final salary. But this system came under strain, as for one thing, it did not take into account the fact that individual’s pay increased over their working lifetime, Peters points out. “In addition, the life expectancy of our pensioners was increasing.”
A new collective pension agreement came into effect in 1967, following negotiations with the trade unions, bringing a compulsory scheme giving members the right to an index-linked pension on the top-up basis. The employees had to contribute 1% of pay to this and with the employers contibuting a further 4.5% of income, the amount of contributions was more than enough to finance the supplementary pensions, he says. “The aim was to create a specific capital reserve in order to prevent later rapid sharp increases in the contribution rate.”
This arrangement was amended 41 times following its introduction in 1967. In 1978 the financial approach changed from a partly funded scheme to a pay-as-you-go scheme. The contribution rate was set corresponding to the current pension payment of the VBL. The reunification of Germany, meant bringing the five eastern Länder into the system in 1997, when the responsibility of managing the assets of the compulsory insurance system was divided into two, with a lower contribution rates for an initial period for the east as there were not likely to be much paid out there by way of benefits.
Partly, as a result of a legal judgment by VBL’s neighbour the Federal Constitutional Court, the top up approach was abandoned and a new agreement came into operation in 2002, introducing a ‘pension points’ model. These points are calculated annually for each person based on earnings, says Peters. At present the benefits are financed by means of the pay-as-you-go system with contribution rates for the western employers now at 6.45% and 1.41% for employees. In addition there is an average overall contribution of 2% to finance the VBL’s pension payment. “In the future we will gradually change to a more capitalised system,” says Peters.
The Riester reforms provided another challenge and opportunity, which VBL grasped as it was concerned with the loss of its captive market under the new freedoms. In October last year, it introduced an additional top-up voluntary coverage based on the points system, called VBL extra,
eligible for the Riester tax incentives. Also being offered this year is a fund-linked voluntary pension product eligible for the incentives, VBL dynamik. Contributions are divided into a savings contribution to meet the requirement of return of contributions and an investment contribution to produce as high a return as possible, he explains.
Most of the E8bn in assets is in respect of the old system, which has to be invested safely and profitably, as Peters puts it. “We undertook an asset liability study and are managing our investment decisions as a result.” Overall, the assets have to be invested according to the insurance investment guidelines, which, for example, limits the exposure in equities to 35%.
But this constraint is unlikely to have much impact as the initial asset allocation is up to 15% in equities, 12% real estate, with the balance in fixed income. “We wanted a very safe starting point. So at the moment we have around 10% in equities, but this proportion is growing. We have a risk buffer, so if equities do well, we can invest more here.” The fund has extensive fixed income holdings, which are handled in-house. The fixed income portfolio is mainly in government bonds euro-denominated but VBL has also been investing in structured products relating to developments in the bond markets.
“Our cash flow is our monthly payments, which we put out into the money markets for a month or two with the absolute security it will be there to pay the pensions.”
But it has used external equity managers for a number of years through a range of Spezialfonds with different asset management organisations KAGS. “Up now, we have had relationships with13 managers of Spezialfonds under the structure in place since 1987, when the fund started with three managers initially and then built up from German only equities to European,” he says.
This year, VBL took the bold step of moving some E400m of assets across to a new structure using the master KAG system, where the investor operates through one investment group, which can set up Spezialfonds with a range of asset managers.
“We have recently taken this step of using the master KAG system, which enables us to use specialist managers from overseas. So we now have access to the whole universe of managers and not just those with KAGs in Germany.” This was done using the Frankfurt-based Universal group’s structure, which provides the administration for these arrangements, initially with six asset managers.
To run such a structure requires precise and up to date information, Peters maintains, adding that manager changes can be accomplished more simply under this system. “For this reason, we decided on using the services of a global custodian, who could provide the flow of information from the managers on a daily basis via the internet. This means we have just one overall performance number, with the custodian being the single source of reporting. This is very necessary for our controls. This will show us how the managers perform, where the risks are, where the costs are and to compare the managers. It will make everything more transparent,” he believes.
“BNP Paribas was chosen here after a beauty parade of the major global players. “The whole package they offered was very attractive. A feature that VBL likes is that the documentation is provided in German, rather than English.
The internal panel at VBL that made the final decision consisted of Peters and two finance experts, and a number of the big backoffice team. They were helped by consultants Heubeck Feri who advised on the asset manager selection for the master KAG structure and introduced the fund to a wider range of managers.
The fund has six managers including global equities mandates and international corporate bonds in the master Kag arrangement. On the equity side the fund is using an enhanced rather than plain indexed approach. “We also have a real estate fund, investing in Europe.”
This is a new departure, as up to now the real estate had only been in Germany and VBL runs this itself through a real estate operation, with a team of around 40 people. “We are keeping this portfolio, which has been built up over 50 years.” It has moved into new areas such as investing in old peoples’ homes, which is seen a growth market for the future.
The point for Peters is that the whole structure is now much more transparent as all the cost analyses are provided by the custodian. “Initially, we expect it to be more costly to set up, but in the longer run we are looking for cost savings.” He compares this with the more unwieldly structure that the fund has had in place for years, with Spezialfonds from a variety of KAGs, both from both domestic and foreign managers. The intention is overtime to transfer assets from these into the new structure. “We will be transferring the old KAGs to the global custodian and to the master KAG structure. This is work in progress, but in the end we will have just one global custodian, and just two or three master KAGs for our whole universe. That would be our scenario for the future.”
VBL is taking a very hard look at its investment approach and is veering towards an absolute return. “We are going towards obtaining an absolute return,” says Peters. “As we have to pay out E320m a month, we need the investments to provide this. But in the last few years the benchmark mandates were not capable of doing that. So we have decided to go more towards absolute return mandates. We are going to change our universe.”
He adds: “It hard to say what proportion will going to these strategies - but it is growing. We are looking at the possibilities and putting a lot effort in to this area and direction.” The total return concepts could be based on equities, on hedge funds and other forms. “So looking at concepts such as Union Investment’s total return product. Balanced mandates are one approach here, but there are other structures which interest us, using a lot of maths. We will be managing our fixed income portion ourselves so that we have a high expectation of absolute return.”
Private equity is another area they are examining and will be making a decision about one way or the other. He acknowledges that this class is going through a bad time, but should bring returns in the future.
Hedge funds investment will be easier next year in Germany. “We are considering different hedge fund systems and will make a decision this year about implementing it next year. We are looking at fund of funds and other approaches.”
The search is on for other areas of returns. Stocklending and currency management are areas which the fund could examine, he says. “The better reporting that the new structure will provide could lead to new possibilities.”
Peters’ demands are not excessive: “The overall return we need is 5% annually and that it not impossible to achieve, though we have been under this level in the last year.” But he believes it is essential to look at innovative measures. “We regard it as the only opportunity you have to manage in the current marketplace.”
VBL has a small team on the investment side, with two experts to handle the fixed income portfolio and to monitor the external equity managers, with backoffice and IT staff. Most of the organisation’s staff of nearly 1,000 is involved in administering payments of nearly E4bn annually to its 996,000 pensioners.
Peters, who is a lawyer by background, has been with the fund for six years. In that time he has had the opportunity to see the investment market operate in extreme conditions. “That has been an experience and very good practice.”